Adapt or Die? Private Utilities and the Distributed Energy Juggernaut

Last week I reviewed some of the disruptive challenges that the private, investor-owned utility (IOU) sector is facing in the transition to distributed renewable energy production, and they are serious. Last month, NRG Energy's CEO David Crane called distributed solar "a mortal threat" to the IOU's business.

The question we all must grapple with is how the utility industry will be transformed by these disruptions, and what the effect will be on consumers.

The first issue is price. The IOUs have warned that more distributed power generation will drive up grid power prices for consumers. That may be true, to a limited extent, but the accounting is complex and the result is anything but straightforward. New coal, nuclear, and gas power plants are expensive too. As I explained last week, within a decade -- less than half the expected lifetime of these long-lived capital assets -- they are likely to be more expensive than renewables.

In fact, price isn't much of a leg for the IOUs to stand on. According to EIA data on all 3,186 utilities in the U.S., helpfully compiled by Richard Caperton of the Center for American Progress, IOUs offer the most expensive grid power in the nation, with an average price of $0.1003 per kilowatt-hour. All other types of utilities -- electric co-ops, municipal utilities, federal utilities, and power marketers -- sell power for less. On average, municipal utilities sell power for roughly half a cent ($0.0046 per kilowatt-hour) less than the IOUs.

It's not hard to see why. In January, the Houston Chronicle detailed how the average CEO pay at major utilities rose from $2.7 million in 2000, just after Texas approved deregulation, to over $7.5 million a decade later. In addition to paying executives more, IOUs must turn profits for shareholders, pay taxes, sponsor legislators, and occasionally fight with consumers and town governments in courts and on ballots, where their non-IOU competitors do not. All of those costs add up to higher grid power prices.

Further, as the New York Times noted in March, nonprofit municipal utilities can obtain tax-exempt financing for capital projects, rather than higher corporate rates. Along with having fewer expenses, this enables municipal utilities to invest more money in grid maintenance and outage prevention, which makes their service more reliable. After Hurricane Irene in 2011, municipal utilities in Massachusetts restored power to their customers in a day or two, while the IOUs took about a week. And in Winter Park, Florida, which converted from an IOU to a municipal utility in 2005, customers now enjoy more reliable service at competitive rates. After taking some short-term losses while it made capital improvements that the IOU had deferred, the utility is now turning a profit and investing in underground cables.

This doesn't mean that municipal utilities are always more responsive, however. The much-publicized failure of the Long Island Power Authority (LIPA) to get power restored after Hurricane Sandy prompted a commission handpicked by Gov. Cuomo to recommend that the public authority be privatized.

Perhaps the grass is simply always greener on the other side of the public-private fence. But where public support for renewables is strong, it seems clear that municipal utilities are more likely to accommodate them than IOUs.

IOU: Intransigent, obstinate, and unwilling

Faced with the prospect of having their revenue streams from generation, transmission and distribution slowly leak away as more distributed renewable power joins the grid, it appears most of the IOUs would rather fight than switch.

PG&E, one of two California IOU monopolies, has a long record of fighting this trend even as it touts itself as a progressive utility. As I detailed in 2010, when Community Choice Aggregation (CCA) entities began to appear in response to residents' demands for more renewable power than their utilities would offer, PG&E fought them vigorously. First it sponsored a public relations campaign under the guise of a “Common Sense Coalition.” When that failed, it put $35 million into a ballot proposition disguised as an appeal to protect the voters’ "right to choose." The proposition would have foreclosed on the possibility of any further CCAs being created in the state, and prevented the one CCA that did exist from expanding its service area. It also failed.

Now, according to a recent E&E story, PG&E is trying to weaken California's net metering law, which requires utilities to credit consumers for electricity put onto the grid by their rooftop solar systems. The California IOUs have fought consistently to artificially cap the amount of electricity generated under net metering as it was raised from an initial 2.5 percent, to 5 percent in 2010, then to 11.6 percent in 2012. PG&E now claims that the net metering law is unfair, because solar owners use transmission and distribution lines but pay less for those services (and contribute less into state assistance programs for lower-income residents, which are funded by grid power consumption) as they draw less power from the grid.

Given the fact that only about 1 percent of the state's energy mix comes from solar, this seems a particularly weak argument to make. Sunrun vice president Bryan Miller characterized it appropriately: "Utilities pretending to be ratepayer advocates is like Cookie Monster pretending to be a slow food advocate." That doesn't mean it's a non-issue, however.

"Net metering is a good thing," Richard Caperton notes. "But the utility line on that -- that it's a cross-subsidization against poor people -- is a real thing, and not just a talking point. I think we're going to see regulators get real interested in those questions again."

Many IOUs have also dragged their feet on upgrading their grids and incorporating new technologies that make it easier to accommodate more renewable power. Most recently, the Illinois utility Commonwealth Edison has been slapped with a class-action lawsuit for failing to comply with a state commerce commission order to upgrade its grid, install smart meters and improve system reliability, although it has been collecting customer payments for the new meters.

Adapt or die

Two weeks ago on Greentech Media, cleantech investor Rob Day opined that utilities should respond to the distributed generation threat by allowing their existing business to shrink until it's essentially just a wire management business, while branching out into new business niches like efficiency upgrades and financing through unregulated subsidiaries. "They would need to embrace that the grid will be the source of kilowatt-hours of last resort in many cases, and stop trying to make their margin off of the kilowatt-hour thus sold," Day wrote. "But it's going to happen to them if they don't get out in front of it. They need to eat their own lunch before someone else does."

Day is right that such a transformation could be a "win for the shareholders of IOUs." But that would take vision, and an appetite for risk and entrepreneurial leadership, which the change-averse utility industry does not have. As Washington, D.C.-based independent energy consultant Scott Thomasson told me, it would require "a cultural shift" that goes against the grain. The intrusion of private equity into the sector that Day wrote about -- the "other financiers and other startups" who "take advantage of IOU inaction" -- amount to "a hostile takeover," Thomasson says, and "the IOUs have no interest in it."

So what will the private utilities do? In an interview with Platts last month, Jim Rogers, the recently ousted CEO of Duke Energy, admitted that "we need a new model to be viable and to be able to deliver electricity in the future and to optimize the use of electricity among the different supply sources." But the alternatives he mentioned -- the "fixed variable" approach used by gas pipelines, or the "formula rate" approach -- spoke of inside-the-box thinking, not the kind of transformative leadership that will be needed for IOUs to adapt. If that's representative of the views of IOU CEOs, then Rogers will be right about their fate: "Some people won't pay attention to [the disruptive changes] and then they'll wake up five years from now and look back and say 'Oh, my God!'"

If the IOUs sleep on energy transition, consumers will find other ways to connect rooftop solar and other distributed generation to the grid without restriction. There is no good justification for a cap on net metering other than slowing down energy transition, which is not in the public interest.

In short, the private utility business will either be made obsolete or transformed back into public utilities.

What happens next in Boulder, Colorado will be telling. If the division of Xcel Energy that currently serves the city capitulates to community demands for more renewable power, then other IOUs may follow its model. But if it does not, and Boulder proceeds with its effort to convert to a municipal utility, that may become the model for the rest of the country.

One way or another, the energy transition juggernaut will move ahead.

***

Chris Nelder is an energy analyst and consultant who has written about energy and investing for more than a decade. He is the author of two books (Profit from the Peak and Investing in Renewable Energy) and hundreds of articles, and has been published by Scientific American, Slate, the Harvard Business Review blog, Financial Times Alphaville, Quartz, the Economist Intelligence Unit, and many other publications.